UK Equity income funds are some of the most popular with our clients. Partly due to the low level of return available on traditional sources of income, such as bank deposits or government bonds. Most funds in this sector aim to generate a rising income, as well as increase the value of your original investment over the long term. Any income can be paid out to you as cash or reinvested back into the fund to help boost long-term growth.
Different fund managers take different approaches to income investing. Some focus on larger companies that are seen to be more stable and have paid regular dividends for many years. Others invest in higher-risk small and medium-sized companies. These might pay a lower income to start with but can have more dividend growth potential. Increasingly some managers also use their ability to invest up to 20% of the fund overseas to add diversification and allow exposure to sectors and industries less available in the UK equity market.
Investing in a dividend-paying company means your income and capital grows as the company grows. The best companies will grow their profits and dividends over the long term, though not all companies’ profits – and therefore their dividends – are sustainable. The extraordinary events of 2020 provided a particularly harsh lesson in this regard for investors as the effects of the COVID pandemic severely impacted upon many companies’ ability or willingness to pay dividends. In general, however, we like equity income funds as an expert fund manager invests in a range of companies reducing the impact if one gets into trouble. It’s less risky and more convenient than trying to choose individual shares yourself.
Interest rates are at historic lows. And they're unlikely to rise significantly in the short term given the effects of the COVID crises. This makes the prospect of regular and growing dividends from some of the UK's most successful companies attractive.
Dividends are clearly important for investors who require income, but an equity income fund can also be relevant for those seeking capital growth. If not required now, dividends can be reinvested to increase the number of shares held, from which more dividends can be taken at a later date. Repeating this process over a long period (known as compounding) is a way to grow capital, though there are no guarantees.
We think equity income funds can provide an important element of almost any investment portfolio. Keeping cash aside for a rainy day is important and an income fund could be considered for savings that aren't needed in the medium term. Reinvesting dividends when you don’t need the income could potentially help your pot grow at a faster rate. However, investments and their income don’t offer the same security as cash, and will go up and down in value, so you could get back less than you invest.
Please remember past performance is not a guide to future returns. Where no data is shown, figures are not available. This information is provided to help you choose your own investments, remember they can fall as well as rise in value so you may not get back the original amount invested.
2020 will live long in the memory as COVID cast a long shadow over our lives. While global stock markets initially grew at the start of the year, investors quickly realised this event presented huge risks to some companies and broader sectors. It also accelerated existing themes, such as the deepening impact of technology on our lives and the longer-term decline in the demand for fossil fuels. Towards the end of the year advances in the progress for a COVID vaccine lifted investors’ mood.
Over the past 12 months to the end of January 2021 the IA UK Equity Income sector returned -9.09%, whilst the FTSE All Share (TR) returned -7.55%, the FTSE 350 Lower Yield index (a broad proxy for UK growth companies) returning -2.41% and the FTSE 350 Higher Yield Index (value proxy) returning -13.72%. Until Q3 of 2020 value investing remained a deeply out of favour and unloved area of the UK market.
Companies whose prospects are linked to the health of the economy (cyclical sectors) were in the eye of the storm and fared the worst at the start of 2020, such as travel & leisure, banks and oil. The defensive healthcare, food & drug retailers and utilities sectors all held up better. The IA UK Equity Income sector underperformed the FTSE All Share, partly as many funds in the sector use a more value-focused investment approach – a style that underperformed companies favoured for their perceived steadier growth prospects.
Many UK Equity Income funds have the potential to hold up better in adverse market conditions. But in this example, the sheer speed and scale of COVID called into question whether dividends could, or should, continue to be paid. Some of the natural hunting grounds for income, such as banks and oil, were hit hard as the pandemic reduced demand for travel and caused significant falls in GDP across all economies. The UK as a major dividend paying market and one in which banks and oils feature heavily was especially affected. Despite an improving overall picture with regard to COVID the UK equity market continued to lag other global indices in 2020.
The longer-term impact of the pandemic on UK dividend-paying companies will take several years to play out. There is some confidence (should the vaccination programme be effective) that dividend payments will recover to a level approaching pre COVID levels. However, some companies and industries, such as oil, may use this as a chance to reduce dividends to more sustainable levels and this could shave a little off the overall future headline yield of the UK market. Overall, we expect the attractiveness of the UK as an income-paying market to persist, especially against a backdrop of low interest rates.
The second half of 2020 saw markets rise quickly. Positive signs of a COVID vaccine, a Biden victory and the perceived resolution of Brexit helped to improve investor sentiment. Some of the more cyclical sectors such as mining, travel & leisure and general retailers performed strongly whilst healthcare, utilities and oil & gas underperformed. Small companies outperformed less risky large and medium-sized ones.
We still think the sector can be an excellent way to grow your wealth over the long term and there is some evidence UK companies look better value than other global markets. Companies paying higher dividends have generally done better than lower-yielding ones over the long term, but there are no guarantees this will continue. Volatility is likely to persist in the near term, especially while the UK continues to battle the pandemic.
In the past 10 years* the IA UK Equity Income sector returned 78.25% compared with the FTSE All-Share’s 71.41% gain. Remember past performance isn’t a guide to future returns.
10 year performance IA UK Equity Income vs FTSE All-Share
Past performance is not a guide to the future. Source: *Lipper IM to 29/01/2021.
We regularly review all the major investment sectors. Here we provide comments on a selection of funds in the UK Equity Income sector. They're provided for your interest but not a guide to how you should invest. If you're unsure if an investment is right for your circumstances please seek personal advice. Comments are correct as at 31 January 2021.
Each of the funds below can take their charges from capital. This can increase the yield but reduce the potential for capital growth. All investments can fall as well as rise in value so you could get back less than you invest.
Our Wealth Shortlist features a number of funds from this sector, selected by our analysts for their long-term performance potential. There is a tiered charge to hold funds with HL. It is a maximum of 0.45% a year - view our charges.
Wealth Shortlist fund reviews
The fund’s managers are disciplined in seeking out companies they think can grow their cash flow, as that’s what ultimately pays investors’ dividends. They also keep the fund diversified, to reduce the impact of any dividend cuts on the wider portfolio.
Adrian Frost, Nick Shenton and Andy Marsh mainly invest in large UK companies, but they also invest in medium-sized and overseas companies if they think there’s an excellent opportunity. Frost is one of the most experienced managers in the UK Equity Income sector, and we think he’s built a talented team around him.
The fund’s been one of the better performers in the sector over the past 12 months, and has done better than the FTSE All-Share too. Although, the fund did still fall in value. Having less exposure to oil and banks compared with the benchmark, as well as key holdings in 3i and the London Stock Exchange, added value. New investments include some companies that are more sensitive to the economic cycle, such as Pearson, but balanced with more defensive names such as Cisco.
We think the managers’ combined skill, discipline and experience puts them in a strong position to deliver healthy income and long-term growth, but there are no guarantees.
The fund managers look for companies which are market leaders with a competitive advantage and predictable cash flow. This tends to be a concentrated fund, so each holding can have a significant impact on performance, both positively and negatively, and can therefore increase risk.
Chris Murphy is an experienced income investor and has managed the fund since April 2009. He was joined by co-manager James Balfour in June 2016.
The managers target an income of more than the FTSE All Share benchmark, alongside capital growth over the long term. The core of the portfolio is invested in high-quality, cash-generative companies, but they also look selectively at companies that are recovering or unloved by other investors. In addition they will invest into higher risk medium and smaller companies. They currently invest more in financials, such as Intermediate Capital, and industrials (Melrose) than the benchmark, at the expense of healthcare and consumer services.
The fund performed well over the past 12 months outperforming both its income peers and the FTSE All Share, although this is no guide to future returns and the fund did fall in value.
Jupiter Income focuses on undervalued UK companies which could pay a dividend, so the fund can add diversification to an income portfolio. This style bias can mean the fund is out of favour through certain periods of the market cycle, as it has been recently.
Ben Whitmore has managed funds for more than 20 years and is very experienced when it comes to unearthing undervalued companies. He is assisted by value fund manager Dermot Murphy. As well as the Jupiter Income fund, the two run Jupiter UK Special Situations and Jupiter Global Value Equity, using the same process and value bias.
Performance has been challenged over the past 12 months and the fund has lagged both Equity Income peers and the FTSE All Share. The managers have been steadfast in their value style, which has taken them into more economically sensitive parts of the market, such as WPP, and away from more highly valued and defensive sectors such as consumer defensives.
We think the fund would work well alongside other UK equity income funds with a different style bias to add diversification.
Siddarth Chand-Lall focuses on income opportunities among small and medium-sized companies, which have more growth potential than bigger ones though they are higher-risk.
Having much of its portfolio invested in smaller companies including AIM listed companies makes this fund different to many others in the UK Equity Income sector. Despite medium-sized UK companies outperforming the broader UK stock market and UK Equity income peers over the past 12 months, the fund has underperformed.
We rate Chand-Lall highly and think he has the support of one of the UK's strongest smaller company investment teams. Most UK Equity Income funds gravitate towards the largest companies on the stock market, so this fund could be a good diversifier to an income-focused portfolio.
The fund blends high-quality dividend-paying companies with some unloved companies the manager thinks have the potential to recover and boost the fund’s gains.
Richard Colwell’s an experienced manager who, unlike many others in the equity income sector, only invests in UK companies. He’s bold enough to invest in unloved and unfashionable companies he thinks have good long-term potential. The fund has performed relatively well over the past 12 months, outperforming both UK Equity Income peers and the FTSE All Share, but that is no guarantee of future performance and the fund did fall in value.
Investments in pharmaceuticals (AstraZeneca) and IT (Electrocomponents) have been beneficial, as has having minimal oil exposure and no banks or miners. The manager has recently added to investments in Hays, Wetherspoons and Compass.
We like Colwell’s sensible approach, doing the simple things well, and think this fund could provide a good foundation for an income portfolio.
The fund has a slightly different objective to other income funds. It aims to provide a rising income, but with lower performance volatility than the market and an emphasis on sheltering wealth in a falling market. This is a trait of Troy’s range of funds and makes the fund a good diversifier compared to others in the sector.
The fund is managed by a team of three, based around the experienced Francis Brooke who has managed this fund since launch. Additional resource was added recently to the team, with an eye to longer-term succession planning. The team works closely with other members of Troy who share a common investment philosophy.
A key element of the approach is to avoid economically sensitive, lower-quality businesses and those that require high levels of investment to keep going. There is a greater focus on larger companies compared to some other income funds, and the managers also invest up to 20% overseas where they find the best opportunities not available within the UK market. This is quite a concentrated fund and so whilst they pay especial attention to minimising losses it could be susceptible if one or more of their holdings were to get into trouble. They like consumer names such as Unilever and Reckitt Benckiser and similar overseas companies such as Nestle. The fund modestly underperformed peers and the FTSE All Share over the past 12 months, but has held up well in falling markets. However, the fund did still fall in value.
This fund invests in Hargreaves Lansdown plc.
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Please note the research updates are not personal recommendations to trade. If you are unsure of the suitability of an investment for your circumstances please seek advice. Remember all investments can fall as well as rise in value so investors could get back less than they invest.
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